The Path of Lease Resistance - Industry Trend or Event

Home Office Computing, Jan, 2001 by Todd W. Carter

Why some small-business owners have stopped buying new equipment

WHEN DAMIAN BRELAND NEEDED A NEW IBM ThinkPad for the information technology (IT) consultancy he runs from his Stafford, Va., home office, he decided to use neither cash nor credit. Instead, the head of Taktix Inc. chose an option that's still not on many small-business owners' radar--leasing the $4,000 notebook through American Express Equipment Financing after finding it on the Web site of computer reseller Zones.com.

"I didn't purchase [the computer], because it's really not advantageous to do that [from a tax standpoint]" says Breland, who makes payments of about $140 monthly and plans to buy the portable at fair-market value when his three-year lease ends. Leasing the laptop "fit into the business model a little bit better," he adds.

A growing number of entrepreneurs are finding that leasing has its advantages when it comes to securing office equipment. For example, by leasing a PC for a few years, you can usually upgrade your technology more quickly than you would with a conventional purchase. At American Express, Chris Sinatra, vice president of equipment financing, says the company's average lease period is about 26 months.

Fixed monthly payments can free up money for other things. And leasing can make sense for property that has a relatively short, useful life span or that will experience a high level of wear and tear.

"People are nervous [and] don't want to invest all of their money in equipment when they start an office," says David Arentsen, a senior analyst with the Knowledge Management Group of Parsippany, N.J.-based ShareMax Inc., which helps companies trim their purchasing costs. On the downside, however, "leasing is like renting forever" he adds, "because at the end of the lease period, you've either got to give [the equipment] up or pay for it." If you choose to lease a newer PC when the lease ends, your payments start all over again.

Truth or Consequences What appears to be a lease, however, does not always guarantee that you'll get the tax benefits of what the Internal Revenue Service offers for what it calls a true or "operating" lease. If you pick the wrong plan and then get audited, the IRS may disallow your deductions.

According to Judith Dacey, an Orlando, Fla.-based certified public accountant and entrepreneurial consultant who runs Small Business Resources Inc., there are telltale signs of what's called a "finance lease," not recognized by the IRS:

* The lease transfers ownership to the lessee at the end of the lease term.

* The lease contains an option to purchase the equipment at the end of the lease for $1 (or up to 10 percent of its original value).

* The lease term is equal to 75 percent or more of the estimated economic life of the property, with some exceptions.

* The present value of minimum lease payments equals 90 percent or more of the fair-market value of the leased asset.

Nor should operating leases be confused with certain time-payment promotions such as Gateway's YourWare program, which lets home PC customers trade in older systems and receive credit toward one of the company's new computers. (Gateway does offer true leases for qualifying businesses.)

If you do decide leasing is for you, how long should you lease office equipment? According to Dacey, photocopiers have a life span of five to seven years before their maintenance costs become a burden. Computers, which get faster and cheaper than their predecessors in six months or so, are less useful after just two or three years.

For such short terms, Dacey says, an operating lease may not be a self-employed worker's best bet compared to paying cash, or financing and depreciating a purchase. At one time, small businesses could deduct lease payments as they were made, instead of depreciating the equipment over several years. But with the introduction of the first-year expensing deduction--also known as the Section 179 deduction--leasing "is no longer the best write-off" Dacey argues.

In tax year 2000, small businesses can make Section 179 deductions of up to $20,000. That increases to $24,000 in 2001 and 2002, and can be carried forward into the next tax year. Moreover, Dacey warns, the type of credit card you use can affect your deduction: Small businesses can benefit from full Section 179 deductions on purchases made with Visa, MasterCard, American Express, and similar cards, but users of store cards can only deduct the cost of the equipment as they pay for it.

And even though interest paid from financing business equipment and services is deductible, Dacey contends it's best to pay with cash. "I'm never excited when I give a whole dollar away to save 28 cents" she says. "It's not a good swap"

Alternatives to Leasing For small businesses that want to avoid both leasing and credit card interest expenses, there are alternatives. For example, many retailers regularly offer special interest-free financing on purchases if the balance is paid within six or 12 months. Sometimes no minimum payments are required, either.